We expect volatility in the share prices of HCV focused companies leading into this year’s AASLD meeting from November 7th to 11th, which we will be attending and covering. In 2013, Gilead (NASDAQ:GILD) was both the focus and clear winner. While we expect the same ultimate outcome this year with little change to GILD’s prospects remaining the HCV leader, we believe that the late entrants have lost significant time, leverage, and competitiveness since the Merck (NYSE:MRK)/Idenix (NASDAQ:IDIX) acquisition this summer. We highlight Achillion (NASDAQ:ACHN) as a top trade idea with our $34 DCF takeover valuation (model in subsequent sections) and $16 SOTP price target as a standalone entity that is solely positioned to take advantage of the inevitable shift taking place in the HCV market. This creates a compelling risk/reward (-50% downside, but potentially >300% upside) setup for 4Q14 into year-end, if data is positive we expect a takeover bid within 3 months of data release.
The focus of this report will be on the growing need for ABBV and BMY to remain competitive in HCV, while BMY has a combination with Sovaldi, ABBV remains “Nuc-Less” and we believe that ABBV’s regimens without a Nuc constitute a high risk strategy that could lead to its market share eroding from 20-30% in 2015 to only 5% by the end of 2018. We believe ACHN-3422, the sole clinical stage Nuc, represents significant scarcity value and upon favorable data a competitive bidding process will be initiated. In subsequent sections, we build the case for a $27-$34 ACHN acquisition dependent upon the strength of data to be presented by December 20th.
ACH-3102 (NS5a inhibitor): It could have a lot of Value
In August, ACHN released combo data with their second-gen pan-genotypic NS5a inhibitor (similar to Gilead’s Ledipasvir) that has an increased barrier to resistance showing 100% cure rates WITH Sovaldi, followed by patent awards for the drug through 2030, this should put a floor on the stock around cash $4 per share. However, this asset has significant intrinsic value, and has been granted Fast Track designation by the FDA. Importantly, it showed higher SVRs than Sovaldi + Ledipasvir. In a Phase 2 Proxy Study evaluating 8 weeks of treatment with ACH-3102 and Sovaldi in treatment naïve GT 1 patients achieved SVR4 100% (12/12). Critically, 6-week combo data with Sovaldi data is due out by year-end 2014, evaluating ACH-3102 with Sovaldi over duration of only 6 weeks. This data set could further differentiate ACH-3102 from other NS5A inhibitors. Recall, in GILD’s ELECTRON-2 PII trial, Sofosbuvir/Ledipasvir + RBV for 6 weeks had a SVR12 of 68%! Thus, any demonstration of superiority to GILD’s regimens further enhances ACHN’s strategic value.
This week AASLD abstracts were released, and some notable disappointments in GILD’s data with its GS-5816 pan-genotypic NS5a inhibitor that was expected to serve as the backbone for an all-oral interferon and ribavirin free regimen for genotypes 2-6. However, based on the abstracts it is apparent that GS-5816 requires ribavirin in genotype-2 patients with SVR12s of only 88%, but did have a 96% SVR12 in genotype-3 without ribavirin. Moreover, Sovaldi + GS-5816 without ribavirin for only 8 weeks had SVR12s of only 90% (26/29). Recall, the FDA’s regulatory threshold for approval since the approval of Sovaldi is now >95% in a “Nuc” environment. Thus, GS-5816 based regimens are unable to claim success as of yet. In our opinion, this mild setback for GILD creates opportunity for ABBV, JNJ, MRK, or BMY to possibly recapture some lost time on GILD’s first-mover advantage.
Past preclinical data (see below) on ACHN-3102 demonstrates its superiority over several late stage NS5a inhibitors from BMY and ABBV, showing higher barrier to resistance and increased potency in generating viral responses. Thus, ACHN-3102 has significant strategic value beyond ACHN-3422 ((Nuc)).
Facts drive both our thesis and confidence:
- Merck’s acquisition of Idenix for ~$4B sets a market value for early-stage clinical Nucs that meet very defined criteria on efficacy (>4 logs reduction in HCV RNA in genotypes 1-3), but with significantly less transparency on safety measures. This transaction secured MRK’s future as a major player in HCV with one Phase 1 Nuc (IDX-437), and another preclinical Nuc (IDX-459 started Ph1 enrollment in Europe in June) with some potential optionality to receive royalties on Sovaldi from ongoing intellectual property arbitration against GILD.
- ACHN is the ONLY remaining clinical stage Nuc on the market, and possesses both scarcity value, and preclinical data indicating potential superiority to Sovaldi in genotype 3 patients (~7-10% of U.S. market, but much larger globally).
- The evolution of the HCV treatment landscape is the antithesis of vague; rather it is unequivocal in our view based on surveys, guidelines, and patient data from Symphony, we conclude that all patients will eventually be treated with Nuc based regimens by 2017/2018 assuming MRK’s IDX-437 is approved (reminder Sovaldi is the only approved Nuc for the foreseeable future), in lieu of only protease inhibitor + NS5a inhibitors (AbbVie (NYSE:ABBV)).
- Furthermore, our thesis is being validated in the data from MRK and Bristol-Myers (NYSE:BMY), showing that both optimal cure rates, and shortened treatment durations with their drugs require Sovaldi! Thus, we conclude that ABBV’s 1st and 2nd gen regimens are somewhat antiquated.
- These threats to ABBV are only reinforced if ACHN’s Nuc ACHN-3422 ultimately secures FDA approval. We highlight caution that all clinical stage Nucs in the past have failed in Phase 2 on safety issues, when combined with other direct-acting antivirals, which makes MRK’s Ph1 acquisition somewhat confounding.
- All HCV companies have ongoing commercialization strategies being studied in combination with Sovaldi, EXCEPT ABBV (Nuc-less, PI+NS5a).
ACHN-3102 vs. Daclatasvir in NS5a Single Mutations
In Double Mutations in NS5a Also
GT 1-6 Data is Impressive
Better Viral Response vs. ABBV’s 1st Gen NS5a
Two Data Releases by Year End Drive Upside
If sufficient data is released, this company is an instant takeover candidate between $27-$34per share. We recently took another look at HCV competitive pipelines and ABBV is the ONLY one not testing in combo with Sovaldi, Enanta (NASDAQ:ENTA) has a preclinical Nuc, but again <3% probability of success, possibly even less.
What does this mean? Emphatically, this translates into Sovaldi being further entrenched across treatment guidelines as 1st/2nd/3rd line therapies and across comorbidities. More importantly however is how this will shape physician-prescribing practices; as all of the competition is testing with Sovaldi, docs will become dependent on a “Nuc” backbone across GT 1-6, this bodes well for GILD as MRK/IDIX Nuc won’t be on the market until 2017/2018, and BMY/JNJ will have data with Sovaldi, this builds the depth and breadth of Sovaldi’s safety/efficacy. In short, ABBV HCV stint may be a lot shorter than current consensus if a 3 Nuc market is realized. If ACH-3422 data is >4 log reduction, ABBV or BMY will pick up ACHN, as their regimens are not competitive to GILD/MRK especially as Physicians move away from protease inhibitors and increasingly more towards Nucs that have fewer side effects or drug interactions, and does not require ribavirin (all of which are ABBV weaknesses).
To date, GILD’s Sovaldi + GS-5816 is the only TRUE pangenotypic regimen (GT 1-6), although recent AASLD data shows that even GILD is having trouble delivering >95% SVRs across GT 1-6. We highlight that ACHN preclinical data shows 7x potency of Sovaldi in GT 3 and is on par for GT 1, the question remains what about GT 2, 4-6? If ACHN data shows GILD like GT 1-6 activity, this company becomes INCREDIBLY valuable.
Building the Case: Nucs Required to Remain Competitive
There has been an extreme misperception propagated by both the media and sell-side bulls of MRK or ABBV who sensationalize every positive clinical data point that comes out from a GILD competitor. However, more often than not, upon close inspection these studies ALL include Sovaldi as a component of the regimen being studied. Thus we fail to share the same forecasts put forth by many leading sell-side firms that GILD’s market share erodes from ~90% today to only 50-55% by 2017. The sell-side’s rationale that competition will only erode GILD’s market share, while not impacting ABBV’s or MRK’s is flawed and does not reflect the reality. The thread that interconnects the overall trend in HCV is that a Nuc is required for optimal treatment durations, and cure rates and we contend that over time Sovaldi will only become more entrenched into treatment guidelines and physicians’ prescribing habits; as it is more frequently being studied in clinical trials as a component with competing regimens. This is undeniably bullish for GILD enabling them to maintain a larger market share as competition enters. This increasingly is bearish for ABBV; as they remain the standalone “Nuc-less” company, note that BMY is studying their regimen in combination with Sovaldi.
There is a pervasive mischaracterization of the competitive dynamics within the HCV market that will create long-term trading opportunities as the Street increasingly becomes aware of their own miscalculation and has to adjust estimates. In our view, the HCV market resembles the HIV market more than it does not (see tables on following pages). Just like the HIV market where GILD-owned assets are a component of 3 out of the top 5 selling HIV regimens globally has translated into 72% market share in HIV, GILD’s dominance in HCV should be even more ubiquitous with the competition actually helping GILD’s first line position, not eroding it!
Validating our hypothesis is the reality that 80% (4 out of 5) of the HCV players (MRK, ACHN, BMY, JNJ) are testing regimens WITH Sovaldi providesproof and validation on the dependence of a Nuc to shorten treatment durations, maximize cure rates, and remain competitive.
More importantly, this enables Sovaldi multiple opportunities for capturing a prescription given the fact that GILD’s competition through at least 2017 will be seeking approval in combination with Sovaldi. Thus, the Street’s estimates are too bullish on ABBV in particular, and too bearish on GILD and MRK. Or more appropriately for this discussion is ABBV has the most value at risk. We expect ABBV’s HCV estimates to come down over time due to MRK’s increasingly leading innovative position in HCV over ABBV. Currently, sell-sides forecasts 100% of the competition’s future market share comes directly at the expense of GILD’s market share (see figure below from Credit Suisse). We question the logic in this assumption given the fact that GILD will be on its 3rd or 4th wave regimen, that will be delivering 96-99% SVR’s GT 1-6, regardless of cirrhotic status or previous exposures to treatment without the need for a protease inhibitor, Ritonavir or Ribavirin.
Source: Alpha BioPharma
Establishing the M&A Motive: By 2018 it COULD be a “Nuc Eat Nuc” World
In this report we focus our analysis on how a “3 Nuc World” would transform the competitive landscape for GILD, ABBV, MRK, ACHN, and JNJ. Please note these are not forecasts (yet), rather an analysis of how ACHN and MRK’s success would change the consensus landscape on GILD ($12-$17B) and ABBV (~$2-$4B). Our analysis reveals that AbbVie has the most to lose upon MRK’s and ACHN’s success. Early in 2014, sustainability was a popular idiom when discussing GILD, our analysis on GILD covered elsewhere refutes this notion on HCV and pricing, however, the question of sustainability was at the forefront of our analysis viewed through the lens of a possible “3 Nuc” market place. In essence, ABBV’s HCV regimens and pipeline simply could not and would not have a place in a future market with 3 Nucs that we assumed both MRK’s and ACHN’s would be discounted to Sovaldi regimens by 10% and 20% respectively. At best ABBV’s regimen could have as little as 3-5% total market share by 2018. Recall, Goldman Sachs and Morgan Stanley throughout this year have been promoting ABBV’s potential in HCV as “underappreciated,” while branding GILD’s as “unsustainable,” consequently ABBV’s estimated market share in HCV has risen dramatically throughout 2014 from $2B to as high as $4B.
We evoke the issue of sustainability in a different context, and ask this: How can ABBV’s franchise be sustainable if it’s the ONLY regimen without a Nuc? Additionally, how can ABBV compete when ALL other competition is studying combination with Sovaldi or proprietary Nuc? And lastly,how can ABBV’s regimens be competitive when global treatment guidelines for 1st, 2nd, 3rd line therapy are Sovaldi based (and we anticipate Nuc based in the future)?
Since Sovaldi’s $4.5B WW sales reported during the 2Q14 earnings season, our views on nearly all facets of the HCV market have shifted and we have turned notably more bearish on ABBV’s HCV prospects (not on the stock as a whole). Again, in a “3 Nuc world,” we argue that “sustainability” for ABBV could be as brief as 3 years before losing >90% of its market share (assuming both ACHN and MRK Nucs are approved). Simultaneously, GILD’s Sovaldi is firmly entrenched within all competing regimens (Olysio, Daclatasvir, MK-5172) clinical development programs as combo-therapy, and global treatment guidelines. If ACHN and MRK are successful, this will translate directly into a bleak future for ABBVs HCV franchise 1st and 2nd generation, it simply would not be on par and will be displaced in treatment guidelines. The caveat of course, is if they are successful, MRK is committing $4B on IDIX’s Nuc, and we anticipate MRK will take >75% market share from ABBV, JNJ, and BMY, and only 25% from GILD in certain settings as Sovaldi’s data is robust across genotypes, subpopulations (transplant, HIV/HCV, cirrhotics etc), and will have 4 years on the market, while ABBV’s regimens simply are not Nuc based during a time when prescribers are clearly preferring Nucs to protease inhibitors.
All of our deductions and analysis stem from multiple Key Opinion Leaders (KOLs), physician surveys, AASLD/EASL guidelines, and analysis of preexisting comorbidities in HCV patients treated this year from Symphony Prescription surveys that effectively coalesce to provide only one conclusion, Nucs are the only path to a sustainable HCV franchise. Our conclusions are unambiguous; we expect 100% of HCV patients in the U.S./EU/Japan to be treated with a Nuc based regimen if both MRK and ACHN’s Nucs gain approval, therefore unless ABBV acts to get a Nuc into the clinic within 12 months they will be THE ONLY HCV company without any data in combination with a Sovaldi-like “Nuc.” Recall, MRK, BMY, JNJ all have ongoing clinical trials in combination with Sovaldi, each one of these directly erodes ABBV’s market share (~75% reduction), we estimate than GILD’s (~25% reduction) given these competitors will still require Sovaldi. In our view, this will prompt them to act upon favorable ACHN data (sometime after AASLD November 11th and before December 20th, the last day of fall).
KOL: “Nucs are king and will remain the standard of care”
Moreover, contrary to consensus we view MRK as a larger competitive threat to ABBV than GILD, as ABBV and MRK will be fighting for market share both entering later than GILD and with inferior products to GILD combos. However, we reiterate that ABBV’s outlook as a company remains favorable despite HCV headwinds, however this is 100% dependent on their Shire (NASDAQ:SHPG) transaction succeeding, which is precisely what we anticipated in July. We view this aggressive business development activity as bullish for ACHN, and as we discuss throughout this report, ABBV MUST buy a “Nuc,” to support their increasingly obsolete HCV pipeline, If they do not, their HCV franchise will shine for a very bright, but brief period of time.
ACHN Weakness on JNJ/Alios Acquisition Provides Good Entry Ahead of Binary Event
JNJ recently acquired privately held Alios BioPharma for $1.75 billion in cash. We do not believe this was HCV motivated. In a press release, J&J clarified that Alios’ drug candidate for respiratory syncytial virus (RSV), a major cause of lung infection that has no current treatment. The drug, AL-8176, is in midstage clinical testing. We believe this as the dominating motive for their acquisition, not the slim prospects of Alios’ two pre-clinical Nucs for HCV, which if anyone views ACHN or IDIX as a “risky” HCV transaction, this would be >2-3x the risk as the probability of success is <3%. Thus, on the surface at least this transaction seems to be RSV oriented, not HCV.
Does this remove JNJ as a potential acquirer for ACHN? We think not. RBC opined the following:
“We clearly think the long-term ‘call option’ upside here is the Alios nukes … if those can show a four-log (99.99%) reduction in HCV virus and have a good safety profile… Of course, that is not a layup, as we know development of nukes can be extremely difficult and the bar for continued progression is very high. As a reminder, Vertex (VRTX) was partnered on two prior Alios nukes and dropped development of both due to a narrow therapeutic window (one weak efficacy, one had signs of liver toxicity).”
Below we show that if ACHN-3422 shows >4 log reduction in HCV RNA, not only would JNJ gain value from ACHN-3422, but would salvage Olysio’s value. Our base case scenario if ACHN’s data meets the threshold would be 10% market share in the U.S. and would represent $1.2B in net-present value (NPV) to JNJ alone. However, assuming Olysio could be used in combination with ACHN-3422 this would generate an additional probability adjusted net-present value of $1.67B, assuming Olysio generates only 50% of 2014E sales. Summing these NPV cash flows, would produce a combined NPV to JNJ of $2.9B or $27 per share. Assuming no tax, SG&A, or other synergies would be $0.16 on an annual EPS basis through 2030, or cumulatively $2.37 per JNJ share.
JNJ is forecasted to generate a steady $21-$23B annual operating profit and $15-17B in free cash flow 2014-2016E (Barclays), while their total debt is only $21B, thus their Debt/FCF is only 1.40x FCF, thus how would a $3.4B ACHN bid change things? The bull case with ACHN would be that it could salvage Olysio sales forecast to decline from ~$2.4B in 2014E to <$300M in 2015E. If an ACHN-3422+Olysio combination were competitive and gained 10% market share, this would represent $1.7B in U.S. sales at peak, and ~$1-$1.2B in sustainable sales in HCV.
In the past we have not viewed JNJ as the likely bidder and continue not to believe them to be the most likely suitor for ACHN as HCV represents a small contribution to their overall product revenues. In our view ABBV has the most to lose as their recent M&A activity has proven they are desperate to diversify away from Humira prior to patent expiration despite the potential for follow on products to replace any loss of Humira sales, ABBV is keenly aware of the need to diversify outside of inflammation, and HCV represents an important pillar to their strategy.
Valuation and Target Price
ACHN represents a great strategic fit for any company with a strategic interest in HCV. ACHN has HCV assets in all classes of antivirals targeting the HCV virus except non-nucs. This includes 1 NS5a, 2 PIs, and one nuke. Indeed, the Nuc data this fall will be the key derisking event for ACHN, and we expect if positive shares to rise somewhere between $16 and $34 per share, which is determined by our SOTP DCF price target and M&A takeover valuation assuming 12% discount rate, pricing that is 20% discounted to Sovaldi regimens, and only 8-9% market share with unadjusted peak sales of $1.1B in the U.S. by 2019.
We note that Sovaprevir is now off clinical hold and a large safety database, we think this gives the company additional leverage in combo therapy. We highlight this company has intrinsic value with the recent ACHN-3122 data showing 100% SVR with Sovaldi in GT-1 with the potential to deliver superior SVRs and shorter durations than GILD’s internal NS5a inhibitors, don’t count GILD out as a potential bidder.
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